Vladimir Putin’s invasion of Ukraine has left Britain on course for a recession lasting more than a year and inflation above 13%, the Bank of England has warned as it raised interest rates for a sixth successive time.
Threadneedle Street said it had no choice but to increase borrowing costs by 0.5 percentage points to 1.75%, blaming Russia for cost of living pressures not seen in more than four decades and a 5% drop in living standards straddling this year and next – the biggest since records began in the 1960s.
Andrew Bailey, the Bank’s governor, said “there is an economic cost to the war”, as he predicted the economy was on course for a period of stagflation – a recession combined with a soaring cost of living.
While accepting the biggest increase in interest rates in 27 years would cause pain, particularly to the least well-off, Bailey said the Bank needed to take action to prevent spiralling price rises from becoming ingrained.
“If we don’t act now to prevent inflation becoming persistent, the consequences later will be worse, and will require larger increases in interest rates,” he said. “Returning inflation to its 2% target remains our absolute priority, no ifs, no buts.”
Hinting that further interest rate increases were likely, the Bank’s nine-strong monetary policy committee (MPC) said it would be “particularly alert to indications of more persistent price pressures, and will if necessary act forcefully in response”.
The MPC expects an increase in the energy price cap to about £3,500 in October to result in inflation rising to 13.3% – its highest since 1980 – and to trigger a five-quarter recession that will last from the final three months of this year until the end of 2023.
With the average mortgage payment expected to rise by about £50 a month as a result of higher interest rates and the average household fuel bill reaching £300 a month, the next prime minister will come under pressure to help households cope with rising costs.
Both candidates in the ill-tempered race to succeed Boris Johnson said the Bank’s gloomy forecasts, which landed with him away on his summer holiday, vindicated their economic plans.
Liz Truss said the prospect of recession underlined the need for her “bold economic plan” to enact immediate tax cuts, while Rishi Sunak argued Truss’s plans would result in higher borrowing, higher interest rates and more persistent inflation.
In its latest update on the state of the economy, the Bank said it expected the looming recession to last as long as the one during the global financial crisis of 2008-09, but to be less severe. Even so, the MPC forecasts unemployment will rise sharply from under 4% to more than 6% by early 2025.
Inflation is expected to remain above 10% into next spring but then to fall sharply to below its 2% target by the middle of 2024.
Central banks around the world have put up borrowing costs to bring down inflation. The European Central Bank recently raised its main interest rate by 0.5 percentage points and US Federal Reserve has rapidly raised rates to a range of 2.25% to 2.5%.
Most economists support such efforts to bring down inflation, but there are growing calls for restraint as economies head for recession and unemployment levels rise, depressing business and consumer spending without the need for further interest rate rises.
Martin Beck, the chief economic adviser to the EY Item Club, said there was little evidence of widespread inflation-busting pay rises feared by the central bank, adding: “The view that underlying inflationary pressures are on the rise rests on limited foundations.”
Economist Danny Blanchflower, a former MPC member, said the Bank had miscalculated the weakness of the British economy, which was poised for a deep recession and needed lower not higher interest rates.
Debt charities urged the government to provide further subsidies for low-income households after an increasing number had turned to high-cost credit to keep afloat. Stepchange said the increase in borrowing costs, which push up mortgage and rent charges, “will increase the pressure on households trying to keep up with their bills and avoid a problem debt situation”.
The shadow chancellor, Rachel Reeves, said the government had “lost control of the economy, with skyrocketing inflation set to continue, while mortgage and borrowing rates continue to rise”.
Labour accused Johnson and his chancellor, Nadhim Zahawi, of being “missing in action” as the cost of living crisis deepened. Zahawi was also away from Westminster when the rate rise was announced, accompanying his family who are on holiday – though the chancellor insisted he was not.
In a statement, he said: “There is no such thing as a holiday and not working. I never had that in the private sector, nor in government. Ask any entrepreneur and they can tell you that.”
Treasury officials said Zahawi and Bailey discussed the economic impact of Russia’s invasion of Ukraine on global energy prices, which they agreed during a phone conversation was the “primary driver of inflation”.
Eight MPC members voted for the 0.5% rise in interest rates, leaving Silvana Tenreyro the only member to support a smaller 0.25% increase. The MPC said inflationary pressures in the UK and the rest of Europe had intensified significantly since the Bank’s last review in May, largely reflecting “a near doubling in wholesale gas prices since May, owing to Russia’s restriction of gas supplies to Europe and the risk of further curbs”.
It said higher energy costs would be responsible for half the 13.3% annual inflation rate in October, with global supply chain bottlenecks accounting for much of the rest.
In addition to raising interest, the MPC also signalled that it would tighten policy accelerating the unwinding the money-creation process known as quantitative easing.
Between 2009 and the start of the pandemic in 2020 the Bank bought £895bn of government and corporate bonds in an attempt to support the economy but is now planning to sell bonds at a rate of £10bn a quarter over the next year.